As recently as the mid-1990s, 81% of business spend was on goods. By 2015, that number had dropped to 44%. The growth of services procurement has therefore been spectacular – and the capability of business to handle this change lags far behind.
The differences between acquiring tangible goods and intangible services is significant. For example, it is relatively more easy to define the requirements for a tangible product and to determine at the point of delivery or acceptance whether it is fit for purpose. In many cases, the source of supply is less important than the price and the need for a sustained relationship with the supplier is often of limited significance. However, for more critical products, or in situations where they are being packaged for inter-operability, buyers have learnt that it is smarter to hold suppliers to account for performance – and in this way, they have driven many former product contracts into being service-based contracts for performance or outcomes. Add to this the growth of outsourcing and professional services and it is easy to see why the transition to a services-oriented economy has occurred.
Services, however, are often much more difficult to define and the criteria for ‘success’ can be complicated and take time to measure. Essentially, we are no longer buying ‘things’, but rather we are buying ‘relationships’. And that doesn’t fit well with the adversarial, price-based negotiations of the past. Control, compliance and commoditization do not align with the need for commitment to long-term value delivery and the importance of agile, adaptable supply relationships. Therefore the three new ‘Cs’ of procurement must be cost of ownership, cooperation and collaboration – factors that demand new criteria for selection and for managing performance.
But the challenge (and the opportunity) goes deeper than simply reforming procurement skills or methods – and it applies to both buyers and sellers. For 20+ years, organizations focused on driving out cost through internal efficiency. They outsourced extensively (to cut fixed costs) and streamlined what remained through massive investments in technology. Today, with most businesses spending 60+% of their revenue on external supply, the room for internal cost cutting is limited. But the opportunity to drive similar efficiencies in external relationships is enormous. That’s because most organizations continue to interface with the outside world as if they were buying products, rather than acquiring relationships. The inefficiencies and tensions in most buyer-seller relationships create enormous value loss and erosion – according to IACCM research, an amount that is on average equivalent to 9% of revenue.
Essentially, in streamlining internal processes, businesses have generated inevitable conflicts when they try to work together. Without extensive human resources, they struggle to adapt and work together in any harmonious way. That is why the contracting process is rising to the fore as the next big area for business transformation. Disciplined contracting can deliver high-performing relationships – but right now, few organizations have that discipline and many continue trying to drive value through dysfunctional processes and adversarial risk transfer.
A recent webinar by Vodafone and SirionLabs was a refreshing example of new thinking and new capabilities. The supply management team at Vodafone have recognized the importance of building contracting and performance management capabilities and have redefined organizational roles and skills. At the same time, they have introduced the dynamic software provided by SirionLabs, designed to facilitate collaborative buyer-supplier relationships through shared governance and performance management data and techniques. In addition to the webinar, you can discover more about this ground-breaking partnership at the IACCM Europe conference in Dublin, May 8th – 10th.
As with so many fundamental shifts in business conditions, it takes time to recognize what is going wrong and how it can be fixed. But any impartial observer could quickly point to the chaotic and fragmented state of buyer-supplier relationships and recognize that there is room for massive improvement. We must indeed stop thinking about buying things and instead start to buy the relationships that we need for success – and of course, equip ourselves to manage them.
Agility – the ability to move quickly and easily – is not an attribute many would apply to contracts or the contracting process. For many, the need for a contract is seen as an impediment, a barrier to getting things done. Executives are among those who regularly call for simplification and speed.
These pressures create a real conundrum for any responsible contracts or legal professional. How do you align the demands for streamlined decisions with the need for due diligence, for protecting the interests of the business or client? A variety of techniques have been tried, with the most common being the use of standard templates and attempts to use power (or frustration) as a means to stifle or curtail debate.
But templates have their limits. Certainly they are not traditionally respectful of the counter-party’s needs or interests. As such, they carry hidden costs – perhaps a premium on price, or missed opportunities, or negative performance incentives. The conversations they stifle can often be of real value.
So today, there seems to be a trade off between agility and value – if you want it fast, you lose quality and eradicate judgment. You also guarantee contention when dealing with another powerful company or trying to handle a more complex transaction or relationship. In other words, one size does not fit all.
Does it have to be this way?
IACCM research suggests that much of the difficulty in contracting arises from the failure to think of it as a life-cycle process. It is instead a series of disconnected activities that feature as steps within other processes – for example, bidding, or sourcing, or sales or project management or finance or fulfilment ….. The terms come from a multitude of stakeholders, the physical components are similarly created in various places and brought together, often at the last minute, in a frenzy of document assembly. Attempts at streamlining are typically frustrated because the stages are in fact interdependent – so for example, if you digitize the form but leave the rest of the process untouched, you have actually introduced greater complexity.
Modern systems support new approaches. For example, a database of terms and term options, rather than fixed templates, can link to opportunity management systems upstream and to obligation extraction systems downstream. Such systems can be adaptive to different industry customers or jurisdictions and to different types of acquisition. The work by IACCM and its corporate members on ‘contract principles’ can streamline negotiation and cause a focus on value, rather than risk transfer. Terms and conditions can be designed to facilitate post-award efficiency, through more adaptive approaches to change management or issue resolution.
Contracts can and should lie at the heart of business value. The failure to develop a structured process has reduced their purpose and relevance – and in parallel threatens the perceived purpose or relevance of those who are charged with their production. There really isn’t an innate contradiction between the terms ‘agile’ and ‘contracts’; it’s a matter of choice and imagination.
It may seem amazing to ask, but what is it that constitutes a contract? More specifically, how would the average person in business answer this question?
Every day, there are millions of transactions around the world, each covered by some form of contract, but often no clear view of the elements that formally constitute part of the binding agreement. I have even heard a lawyer say “Oh, you mean the scope of work …. I was talking about the contract”.
Or take this example, which comes from one of the world’s biggest business software companies, which claims to cover the contracting process: “Typically contracts are focused on language and wording. Although there is negotiation on some terms, the primary focus of contract negotiation is to finalize the wording. In Sourcing, the primary focus is to get agreement on pricing, terms, and what is being sourced.”
I understand there are different sections of ‘the contract’, but ultimately it needs to operate as a coherent basis for performance. The driver for establishing an agreement is economic, because there is a belief that mutual value can be achieved. A contract defines that value, it sets the terms under which it is to be delivered, the responsibilities the parties have to each other and the consequences if they fail. Negotiation may or may not be needed – but shared understanding and commitments are essential. That is about far more than ‘finalizing the wording’.
Today’s confusion creates a wide range of problems – many of which are outlined in IACCM’s ‘ten pitfalls’ and analysis of the cost of poor contracting. It leads to absence of understanding, late engagement of commercial resources, a focus on risk transfer rather than risk management …. the list goes on.
Contracts are a reflection of business intent and capability. In my experience, organizations that place little value on contracts are often among those that experience low growth and margin, quite simply because they lack internal discipline and cooperation. While this may have limited impact in the world of commodities and catalog buying, it spells potential disaster for more significant acquisitions.
When it comes to decision-making in business, what’s of greater value – a person with facts or a person with opinions? The answer, of course, is something of a blend. Good decisions often rest on the use of informed judgment.
Trading relationships are often established through a combination of fact and opinion – but unfortunately not an effective blend. This is due to a variety of factors, rnging from difficulty in establishing the facts through to internal processes or managemnt systems that impose narrow criteria and little room for judgment.
As examples, Procurement, has tended to operate a supplier selection process that demands facts, but only a selective few, which in themselves may not be good indicators of real value. Sales teams, also driven by highly focused incentive schemes, tend to do the same. Lawyers, on the other hand, often base their recommendations or decisions on ‘professional opinion’, a narrow view of risk that may be entirely consistent with classical legal theory, but may have little direct relevance to the overall business situation in hand.
In combination, such blends of fact and opinion regularly undermine business results. They lead to the wrong supplier, or suppliers with the wrong motivations, operating under inappropriate or incomplete contract terms. The result is frustration within business units, who may perceive support groups like contract management, procurement and legal as an impediment to their work. Indeed, in a study currently being conducted by IACCM, the business groups in one major corporation see contracts as irrelevant and contact with their in-house legal team as something to be avoided at all costs. This is hardly a healthy perspective.
For many relatively standard transactions, the absence of ‘informed judgment’ may be of minor impact (though cumulatively it could be significant – few people know). But in larger and more complex relationships, it is frequently lethal. It’s also bad news for the commercial teams that are supposedly supporting the business because their reputation is important for their future.
It doesn’t have to be this way. Support groups must look outward, to discover not only the thoughts and needs of their business units, but also beyond, to the leading practitioners in competitors or other industries. The potential to change measurement systems, to introduce new sources of data, to undertake work on benchmarks and norms, has never been greater, so there really is no longer an excuse. ‘Informed judgment’ should be the mantra.
Anyone involved with public procurement knows that the terms and conditions of contract are often onerous and inflexible. Past IACCM research indicated that a substantial price premium results from these terms – essentially, a cost of risk aversion. We also know that the rigidity of contract structure can contribute to costly failures and overruns.
But to what extent do public procurement rules limit competition? Ensuring fair and open competition is, after all, at the heart of these regulations, so it is ironic if the impact actually reduces market participation. A major problem here – as with so much regulation – is its inability to keep pace with change. Over recent years, we have seen growing public sector reliance on the private sector and a massive shift in the volume of services acquired. The change has also been in the nature of what is acquired – moving from a world of largely direct, commodity acquisition to an environment where growth has been in the procurement of complex – often unique – services and solutions, especially in areas of technology and outsourcing. The levels of risk are fundamentally different. the extent of IP investment and the duration of the commitment can also be extreme. In such circumstances, the extent of market engagement and the skills required to oversee commissioning and delivery have been challenging – but standard contract models do not take account of this fast-moving environment.
Another big question is the extent to which national governments consider the procurement rules to be sacrosanct. Their rigidity is supposed to create a level playing field, but the inability of negotiate is clearly an impediment to good commercial decisions. So do some governments exercise greater levels of flexibility and judgment than others?
To build on its research in important areas such as these, IACCM is exploring the competitive impact (to what extent firms decide not to bid and the particular terms that most impact that decision) and also the consistency (or inconsistency) in major EU countries (both of response and also the extent of negotiability). Our focus is on IT, software, telecommunications and related outsourcing / services since it is in these areas that the greatest tensions (and many of the most visible failures) occur. Early returns show that there are interesting variations between the way companies deal with procurement rules and in the way that governments interpret them. Given the nature of the research, replies to this survey will remain entirely confidential and it will not lead to any published report except to those who participate. The survey can be accessed at https://www.research.net/r/EUterms
Is it lack of trust, the difficulty of making a sustained effort, an inability to coordinate behaviors? When it comes to building collaborative business relationships, numerous reasons are advanced as to why success stories (at least at a substantive level) are so rare. This week, I became aware of yet another report – this time from KPMG and related to the defence industry – that repeats the mantra. In spite of exhortations by executives, businesses simply don’t collaborate easily or well.
At IACCM, we have the opportunity to study the dynamics of collaboration on a practical level almost every day. Having brought together a community of people who are intimately involved in the formation and management of trading relationships, we obviously gain insights to their problems. But the fact that we embrace both buy-side and sell-side, people from Legal, Procurement and Contract Management, means we have a unique community. A belief in the benefits of collaboration underpins our existence and makes us very different from other highly partisan and ‘competitive’ professional associations.
In part, it is this very tendency to competiveness that is often a barrier to cooperation. To a degree, competition is driven by fear and insecurity – a belief that ‘I will flourish only if others fail’, that I must be loyal to my tribe because those outside my tribe will potentially hurt me.
Reflecting on our experiences, I find the biggest barrier to be the fear by management that collaboration may in some way undermine the loyalty of their people or potentially compromise their personal control due to possible ‘split loyalty’. Expanding on this, the prospect of relying on the performance of someone from outside your ‘tribe’ is worrying, even scary. This is perhaps especially challenging in a command and control structure like the military, where traditionally you are either ‘with us or against us’.
Yet on the other hand, modern conflict may have made the military mind more nuanced, recognising that there are not such absolutes and that judgments must be more pragmatic. Which is perhaps why we are in fact seeing more rapid progress towards formalized collaborative networks (and relational contracts) in the defense sector than in any other.
Right now, we see success in situations either where collaboration is temporary and focused on a specific and mutual goal – e.g. The Olympics – or where there is a readiness to embrace new ways because there is a leader who does not feel threatened by the idea of collaboration and shared control. The biggest difficulty seems not to be to do it once, but rather to do it replicably.
Despite the push for greater collaboration, we must also recognize that doing things through collaboration is not always the most effective and efficient way – sometimes you just need to push ahead. I think the real challenge is having methods to gauge the extent to which collaboration is required or beneficial – and without that mechanism, it is easier to operate on a model where planned and active collaboration is the exception rather than the norm. We often see this applying within organizations, where individuals prefer to make unilateral decisions and it si only through rules and process that consultation and cooperation occurs.
So as I reflect on our experiences, I think the key to greater collaboration is not finding the mechanisms – I believe we have those; it is to determine the circumstances or criteria that merit the investment in a collaborative structure and applying appropriate tests to ensure counter-parties have the ability to collaborate. Maybe this is where we must focus some time and effort, to turn collaboration from anecdotal success stories into a suatainable and repeatable capability.
When you aren’t sure what purpose something has, it is impossible to measure whether it is fit for purpose. Or alternatively, when it is multi-purpose, we run the risk that it does many things, but none of them especially well.
That is precisely the problem that we have with contracts. Are they instruments designed for court rooms, or perhaps they are financial assets, or possibly operational guides? Whose interests do they reflect – the buyer, the seller, individuals or functions that form part of the buyer or seller; or are they perhaps communicating the interests of third party advisers or of regulatory authorities?
The answer, of course, is that they are to some extent all of these things and hence have multiple purposes. It is this that often results in complexity or confusion, the challenge of melding multiple interests and perspectives which are themselves often in conflict. But beyond this challenge of reconciling and agreeing views, there is also the question of who they are designed for and the difficulty this generates in making them easy to use or understand. A consequence is that they really are not very good at meeting anyone’s interests and that is why so many are tempted to consign them to a drawer (or the technological equivalent).
Does it have to be this way? Certainly it is in the interests of business to think differently, because for all their importance, contracts do a very poor job. Research shows that in process, form and content, they fail to drive optimum business results – and often do not even do a good job of protecting interests in the event that litigation occurs.
The pressure is growing because the nature of what we are contracting for and the environment within which we are contracting continue to change. For the contracts professional, those changes manifest themselves in the form of ‘complexity’. But much of the complexity is again because the process, form and content is no longer appropriate.
Organizations are awakening to the need for transformation, but are uncertain about how to get started. That will be the subject of my next blog – and is also a focus of the IACCM 2017 conferences, the first of which will be in Dublin, May 8th – 10th.